Author: Mike Holman

As discussed yesterday, we laid out a retirement calculation for Bob, and concluded that he won’t have enough money to reach his desired gross income of $45k in today’s dollars.

What to do? Well either Bob can cut out a few lattes and spa treatments in retirement or he increases his annual contributions or he works a few more years or some combination of all three. The spreadsheet linked below, shows in the first tab named “increase contributions” that he would have to increase his contributions in today’s dollars from $10k to about $19k in order to meet his requirement of $45k in retirement. This amount of contribution probably isn’t realistic given that it’s a huge increase and if he has to double his contribution then he probably has to cut back a lot on his pre-retirement life which might affect his desired spending in retirement. For example if he can live on less money while working then he can live on less money on retirement.

The next two alternatives cover the options if he wants to work later or wants to reduce retirement income.

The second spreadsheet tab named “work longer” – Bob decides that that he can’t live without the lattes and spas either before or after retirement so the only other option is to work longer than age 60. In this case he need $1.1 million in today’s dollars to meet his requirements and has to work until the end of the year in which he turns 65 to fulfill this scenario.

In the last example named “compromise” – Bob says that he can cut some expenses so he will only require $40k in retirement, he will contribute $14k per year but still wants to retire by age 60 – in this case he will have a gross income of $40,690 upon retirement.

So to sum up, Bob can keep his $45k gross income requirement in retirement but he has to work an extra five years to age 65 or increase his contribution from $10k to $19k. Another solution is to work to age 60, increase his contribution to $14k and live on just over $40k in retirement.

Some future posts will deal with more realistic retirement scenarios. If there are two parties involved, Canada Pension Plan, OAS, pension income, and taxes then the scenario becomes a bit more complicated but it’s still relatively easy to calculate.

How to Predict the Future Part I

Retirement SpreadSheet

That’s right – predict the future! Ok, this method won’t help with lottery tickets, horse racing, stock prices or anything else that will make you rich quick, however it does apply to retirement planning, particularly with predicting the future values of your retirement income and retirement expenses which of course is all you need to calculate to predict your retirement. Planning your retirement is not as simple as tying your shoes but it’s not so complicated that you have to pay an advisor thousands of dollars to figure it out for you.

Everyone has heard all the scary stories about how you will need one million dollars to retire, or two million…or whatever. These numbers sound unreachable for someone who might only have a retirement portfolio of $100k (or no retirement portfolio for that matter) but it’s important to remember that these are future dollars. One million dollars in twenty years is the equivalent to $560,613 dollars right now assuming 3% inflation. This is admittedly still a large number but it’s a lot less than a million dollars.

In the past, to calculate my retirement scenario, I had assembled a complex retirement spreadsheet that involved using the future value of all contributions, withdrawals, taxes, income etc. This worked reasonably well except that it was complicated and didn’t lend itself to change very easily. One of the things I learned from Four Pillars of Investing was to calculate retirement scenarios using today’s dollars to greatly simplify things. The way this is accomplished is to subtract your estimated inflation rate from your estimated portfolio return to get a “real return” and to use today’s dollars for everything else such as portfolio contributions and anticipated withdrawals.

I’ve created a relatively simple retirement scenario in the spreadsheet below, which is for someone (Bob) who is turning 40 this year, has a $250k portfolio and contributes $10k per year. He desires $45k of gross income in retirement at age 60. His expected investment return is 7% but I will subtract 3% inflation to get a real return of 4%. We will also assume that he will get no other income other than from this portfolio and that contributions are made at the end of the year. He will retire at the end of the year in which he turns 60. The goal of this exercise is to determine if he is contributing enough to meet his goal of $45k (in today’s dollars) gross income in retirement. We will also use the “4% rule” which basically states that the initial annual withdrawal from a retirement portfolio should be 4% of the portfolio. This will be discussed in many future posts as it is a particular favourite subject of mine!

If you check out the spreadsheet you will note some interesting things. By age 60 his $250k portfolio has grown to $889k in today’s dollars. Twenty years from now that portfolio will actually be $1,654,516 in year 2027 dollars. This sounds like an incredible amount but it isn’t enough to meet the Bob’s requirement of $45k gross income in today’s dollars. I calculate the portfolio each year by multiplying the previous year value by 1.04 and adding the contribution to that.

As you can see at the bottom of the sheet, 4% of $845k is only $35,575 which falls far short of Bob’s expected gross income.

Tomorrow we will look at a couple of solutions for Bob so he can achieve his goals.

How to Predict the Future Part II

Retirement I

Ever get a traffic ticket and just paid the full fine and accepted the points? If you wanted to try fighting or reducing the ticket, there’s always been the option of booking a court case and showing up and either pleading down the ticket with the assistant DA or actually going to trial and hope the cop doesn’t show up. Both of these methods can be successful but they can take up a lot of time and be somewhat stressful – especially if you’ve never been on trial before.

Well my wife got a ticket last year and decided to take advantage of the City of Toronto Court Services process in which you can “plead guilty with an explanation” and basically plead down the ticket with the assistant DA. Actually the cop who gave her the ticket told her to go and plead it down.

According to the website it sounds like a quick easy process, but in practice she showed up and got a number (you have to line up to get the number first). The room was hot and crowded. After about a one hour wait she talked to the customer service rep. Then she went into another room (through security) and waited longer to talk to the assistant DA. Once that talk was over she waited some more and then got a sheet from the assistant DA with the new deal – then she went back to the first room and got another number and waited to pay – this was a different line so it didn’t take long.

Bottom line is that she was there about 2.5 hours, got the ticket reduced from $110 to $80 but she paid $20 for parking so net savings (not counting gas & lunch) was $10. The two points were removed which apparently is the main thing. I’m not sure if two demerit points has any effect on your insurance but I guess if you keep getting them then your insurance will go up.

Tip #1- If you are doing this and are going to the downtown Toronto court then go before nine in order to get the early bird parking which is only $10. It gets crowded later in the day as well so earlier is better

Tip #2 – Don’t bring your young child with you (if you have one).

Tip #3 – Since you have to go through security, don’t bring any knives or Swiss army knife key chains.

One of the efforts I had thought about doing for retirement planning was to measure my personal inflation rate in order to have a more accurate value to use than the CPI value. Realistically it’s not going to work – there are too many variables and potential changes in lifestyle. For example over time, our interests may change from cheap hobbies to expensive hobbies, our young son will probably eat more as he gets bigger and will require more money for activities. It will be difficult to separate the basic “retirement spending” from normal spending. The other problem is that there is a fine line between personal inflation rate and plain old overspending. At some point if you are going to retire you have to be able to live within your means even if that entails reducing or eliminating expenditures on activities that you enjoy.

Fabrice Taylor writes in the Globe & Mail about the fact that the CPI doesn’t necessarily match up to the inflation rate that you or I might experience within our lives. This figure is very important for retirement planning since the real rate of return of your investment portfolio is the actual return minus the inflation rate. Taylor refers to a study done in the US which says that the real inflation rate is twice as much as the official rate.

Another good example is financial planning for education costs. I’ve read that post-secondary tuition has gone up about 5% per year over the last decade. If you are doing projections for your education fund then using the CPI will understate the actual inflation since tuition is a big part of the school costs.

Since I’m still a few years away from retirement I don’t worry too much about my assumptions for rate of return and inflation. Personally I use 3% inflation in my calculations which is probably a good enough estimate for my purposes.